What is Scalping?

When Forex traders talk about scalping or scalping strategies they tend to be referring to trading strategies which see traders enter into positions for only a short period of time. It is for this reason that scalping is sometimes also referred to as quick trading. Most scalpers do not keep positions open for any more than a few minutes, there is however no formal definition of what constitutes scalping.

Scalping as a trading strategy is particularly popular among spot FX traders who are able to use the ample amounts of leverage on offer to potentially make impressive returns from even small movements in the price of a currency pairing. Supposing a trader opens a one Lot position in the EUR/USD could make a $50 profit from just a 5 pip move in their favour. Of course if the market moved the other way a trader would be out of pocket for same amount.

Occasionally, the term scalping is used to refer to other things than quick trading. Scalping can be used to describe certain types of arbitrage trading and can also be used to describe certain forms of market manipulation. However, scalping is most commonly used to describe any type of trading which seeks to profit from quick momentum trades.

Brokers and Scalping

Not all brokerages take a favourable view of scalping, with some brokerages looking to limit or ban traders from using scalping strategies. Brokerages which place limitations on scalping, tend to be operating using a Market Making model and may not be able to adequately hedge the risk posed by traders who are engaging in scalping. Though again there are a number of brokerages who operate as Market Makers who are more than happy to accept the trading activity of scalpers with no limitations. There be a number of other reasons why a brokerage may take a dim of view of scalping, the issue is fully explored in our ‘Why Do Some Brokers Ban Scalping?’ article. It should be noted that brokerages which genuinely operate using a STP/ECN model, should have no problem with scalpers who will generate the brokerage revenue no matter what trading strategy they choose to adopt. If you intend to engage in scalping it is important that you get a clear answer regarding your prospective brokerages position on the matter before depositing funds with the firm.

Importance of Tight Spreads

While it is always important to look around for competitive spreads, scalpers should be particularly interested in the spreads on offer at the brokerages they are considering. With scalpers often only looking to take advantage of 5-10 pip movement, significant spreads can seriously eat into profits/increase the extent of a traders losses. While Spreads are one important factor for traders to consider, traders should also take a number of other factors into account.

Execution/Slippage & Liquidity

The quality of execution is also vitally important for those looking to scalp the FX markets. Slippage can seriously damage the performance of a scalping strategy and while some slippage is to be expected, it is vitally important that the brokerage can execute and close your orders with little slippage. Often the quality of execution will be dependent on the pool of liquidity that the brokerage has access to, which means its worth doing some research to find out what other traders think of the quality of the brokerages execution.

Risks involved

Many are attracted to scalping strategies, as the idea that you can get in and out of trades taking a small profit sounds both plausible and attractive. It should be noted that scalping can be risky, as it can only take one wrong decision to wipe out all the gains you made from successful scalps. Many scalpers don’t have a clear idea of why they are entering into a particular trade and fail to set stop losses. It is often said that scalping is one of the riskiest trading strategies to adopt, and this is in part down to traders use of excessive leverage which can really work against traders if risk isn’t managed correctly.

Conclusion

Scalping refers to a trading style which sees traders enter in and out of positions quickly, with traders looking to take a quick profit while limiting their exposure at the same time. Scalping is particularly popular among FX traders who are able to use the large amounts of leverage available to make significant profits from small movements in price. This means that scalping strategies can be very risky. Despite this many traders engage in scalping. Not all brokerages are receptive to scalping nor do all brokerages provide great trading conditions for those looking to adopt scalping strategies, this means that those interested in scalping should do thorough research before picking a brokerage.